Asset Sale Delays May Push Chesapeake Debt Target to 2013

Chesapeake Energy officials Friday touted the "impressive growth" in its liquids production and "significant financial progress" but acknowledged that some planned asset sales - to meet its long-term goal of reducing its debt to below $9.5 billion - would extend into 2013.

Chesapeake CEO Aubrey McClendon said in a statement that the company remains on target to reach its goal of 250,000 barrels per day of net liquids production in 2015. Three years ago, Chesapeake was producing only 33,000 barrels per day of liquids. Today, Chesapeake's current liquids production exceeds 140,000 barrels per day, even after excluding 21,000 barrels per day recently sold in its Permian asset sale.

Chesapeake recorded average daily production for the third quarter of 4.142 billion cubic feet equivalent, up 24 percent year over year from 3.329 billion cubic feet equivalent and 9 percent from the previous quarter's average daily production of 3.808 billion cubic feet equivalent, McClendon noted during the company's third quarter earnings conference call Friday. The company on Thursday reported a $2.1 billion net loss because of write-downs of some assets.

The production increase comes as Chesapeake seeks to refocus its asset base towards a more balanced one between natural gas and liquids production. In line with that production shift, the company's oil production grew to 8.9 million barrels in this year's third quarter, up from 7,325 million barrels for the previous quarter and 4,589 million barrels for third quarter 2011.

While the Eagle Ford delivered exceptional growth for the company, Chesapeake's oil production grew from production across multiple basins, including the Eagle Ford, Cleveland, Tonkawa, Granite Wash, Hogshooter , Marcellus and Utica, McClendon said.

For the third quarter in 2012, the company's year- over-year growth rate of gas production was 19 percent, or approximately 523 million cubic feet per day. Its year-over-year growth rate of liquids production was 51 percent, or approximately 48,450 barrels per day. The company's natural gas liquids production for the third quarter was down by approximately 467,000 barrels, or 5,075 barrels per day, due to Chesapeake's decision to reject rather than process ethane in certain basins, which also was additive to natural gas production.

Due to its redirection of its drilling program, Chesapeake estimates its gas production to decline approximately 7 percent in 2013 and expects its liquids production to rise approximately 29 percent next year, the company said in its third quarter 2012 earnings statement. The company has also switched from a strategy of identifying and entering emerging plays to a harvest asset phase.

The company also recorded increases in its adjusted earnings before interest, taxes, depreciation and amortization and operating cash flow of 27 percent and 25 percent respectively.

While capital expenditure spending was higher in the quarter than anticipated, McClendon said the company still has a number of associated costs that will go away.

"Some people lost the point that we reduced our leasehold spending by $250 million, which is a forward looking indicator of CAPEX [spending]," McClendon noted.

The $2 billion term loan to debt investors that Chesapeake is seeking is priced at attractive terms and will give the company additional flexibility through the fourth quarter and excess liquidity ahead of the winter season, presidential election and year-end fiscal cliff.

Chesapeake has sought to shore up cash flow by selling upstream and midstream assets, with a goal of selling between $17 billion to $19 billion in assets by year-end 2013. Company officials currently are negotiating new transactions.

McClendon admitted that its planned sale of non-core Eagle Ford assets was proving to be a frustrating process. The company initially marketed the asset package to Asian companies for a possible joint venture, but it became clear that the "notion of getting something done could be more complicated", so the company turned to the U.S.-based industry instead.

"We're in discussions with a number of companies, and would also consider a 100 percent sale at this point," said McClendon, noting that an agreement would likely not be in place until next year.

The company also is continuing to pursue a joint venture and/or sale of part of its Mississippi Lime leasehold, and expects to announce a sale by the end of 2012, the company said in its earnings.

McClendon attributed the reduction in its Eagle Ford rig count to greater drilling efficiency, noting that the company will achieve its targeted well count goal with fewer rigs that would have been required in 2010-2012.

Company officials anticipate greater drilling capital efficiency across its operations by focusing on the "core of the core", or assets with the highest rate of return, and improved logistics and economies of scale in its operations.

McClendon said he believes Chesapeake will be able to drill more than 1,000 wells in its core area of the Niobrara play in Wyoming's Powder River Basin. Production from the Niobrara is just beginning to rise due to the time and capital needed to build out gas processing and pipeline takeaway infrastructure, the company reported in its earnings.

"The company expects a much larger contribution to production growth from the Niobrara in 2013 and beyond as midstream constraints are reduced."

"It has taken time to transition from an efficient gas machine to a liquids machine, but the shift to liquids is proceeding ahead of expectations," said Steve C. Dixon, executive vice president of operations and geosciences and chief operating officer.

Chesapeake, the second largest natural gas producer in the United States, and other U.S. producers have switched their focus from gas to oil and liquids drilling due to low domestic gas prices. However, McClendon said the reduction in U.S. gas storage supply, declining rig count due to weather and growing natural gas demand. These factors, and an anticipated multi-year rebound in gas prices due to future demand, have positive implications for the natural gas outlook.

Despite current gas prices, McClendon considers its Haynesville assets to be one of its 10 core asset groups, anticipating an increase in gas demand in the next one to five years.

The company's board of directors has not yet signed off on the company's 2013 outlook, McClendon noted. The company will not change its approach towards liquids-focused drilling if U.S. domestic gas prices rise between $4/Mcf and $5/Mcf, but would reevaluate its strategy if prices increase to between $5/Mcf to $6/Mcf.

"The Marcellus is certainly competitive with oil projects in that range, but the Haynesville may still be a toss-up," McClendon commented.

While the Utica shale seems gassier, McClendon said the company went after the wet gas and liquids in the play and is simply waiting on the build-out in midstream infrastructure before it picks up drilling there.

The company, which has a joint venture in place with Total for its Utica wet gas assets, still plans to pursue a joint venture for its dry gas assets in the Utica. McClendon anticipates that 2013 gas prices will become attractive enough to warrant a joint venture, with companies looking for U.S. gas exposure as the prospect of more U.S. liquefied natural gas exports comes to fruition.


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